China’s Economy – Government Intervention in Real Estate – Part 2

Continuing on from the last piece, it’s clear that a small handful (in terms of 1.3 billion people – you’d still have trouble fitting all these people in your living room) of very rich people have been driving China’s property boom.

Ordos Mongolia... the ghost town.

This isn’t good, it means that millions of residential units in China lay unoccupied whilst millions cannot afford a home, and even find their ability to rent restricted. And every day this ludicrous situation leads to increasing property prices even in areas where no-one actually lives at all just like in that extreme example – Ordos.

Lessons from Japan are well understood by the Chinese government.

In a finance driven property market this wouldn’t be such a problem, lenders would put the brakes on the market (if they had any sense and as the West knows all too well – there are no guarantees of this) because they’d understand the levels of risk associated with getting their money back. But China’s real estate industry doesn’t work like that – most of the properties are bought and paid for. And it’s impossible to persuade a Chinese investor who doesn’t need the liquidity that he needs to sell for less than today’s perceived value of the property. Even in a situation like now, when it’s clear those valuations are ridiculous.

If this were to continue unabated there would be serious issues down the road. Firstly China’s rural population will never move to the cities – and that’s in direct contradiction of the government’s road map for improved living standards and working towards becoming a fully developed nation. Secondly, eventually even rich people find themselves facing liquidity crises – all it takes is a substantial jolt to the general economy. Then when they decide to relieve themselves of their vast holdings (some individuals will own tens of thousands of empty units) they’ll find no-one is able to buy them for “what they’re worth”. That would cause a collapse of property prices in a similar way to what happened in Japan in the 90’s and the West in the 2000’s and it would be far more severe – because the “over-valuation” is that much higher.

In the West our governments would allow this to continue, just as they did for our own “hard landing”. We’ve seen firsthand why this isn’t a good idea, it causes economic collapse and untold misery for millions of ordinary people. But China isn’t the West and its government writes rules that are in the interests of China – and a property price collapse is in no-one’s interest, except possibly for the sideline economic observer, who could thrill at watching the whole event unfurl.

Why isn’t it in the interests of poor people? After all a huge collapse in pricing would enable them to buy their own homes today – wouldn’t it? Not really, the events leading up to the demand for liquidity by China’s super rich would almost certainly be events that put many of those people out of work – possibly for life. And when you have no income, it doesn’t matter how cheap a house is – you can’t afford it.

It’s not in the interests of the emerging (and admittedly tiny – as a proportion of 1.3 billion people) middle class either, they’ve bought their home (not multiple units – a single home) and again events would conspire to drive them out of work and leave them unable to make their mortgage payments whilst facing negative equity.

And obviously it’s not in the interest of the mega-rich, though it’s hard to summon too much sympathy for those people – at this point their interests coincide with everyone else’s.

So the Chinese government is intervening to create a “soft landing”, they’re doing this by restricting ownership of new homes – in Shenzhen for example you can now only own a maximum of two homes per family (that’s not per individual in a family – that’s per family and spans all generations of that family).

Shanghai's property market is already feeling the effects of new policies

It is having some impact, in Shanghai in the last 3 months of last year – property prices began to slide substantially without dropping so dramatically to cause a panic. However despite this – property sales also fell to an all-time low. That’s because investors are waiting for the market to recover – because they can afford to, they aren’t facing liquidity issues today.

It’s going to be interesting to see if this can be managed without more draconian legislation being implemented. At the moment, the main effect of the policy is to drive investment inward towards Tier 2, 3 and 4 cities where controls aren’t being implemented and property prices are lower than in Tier 1 destinations.

However it plays out, the Chinese government will be able to clearly demonstrate that they took action to try and prevent a crisis. In my book that puts them several steps above our own governments who didn’t interfere and have enabled a group of greedy bankers to ruin a generation of lives instead.

I hope so too – it’s quite strange but Beijing at least seem to have a plan for the economy here, I compare that to the UK where our politicans seem to be headless chickens and it makes me quite jealous.

It really is just the hassle – for example in most areas rents of 2K are a norm per month, so that means an initial outlay of 20-40K to do a place up for habitation (at a really basic level) and Chinese tenants aren’t famous for looking after facilities, so it takes up to 2 years to recover the fit out spend. And then the tenants leave, and it starts all over.

I’ve talked to wealthy property owners here and they scorn the idea of renting as too much work for far too little return. And when the Chinese tell you that – you know there’s no money in it, because they are the most practically frugal people I’ve ever encountered.

My wife and I bought our apartment in January of last year. That was just before a new policy was put into place that would’ve cost us an additional 400K RMB in taxes.

There was also a new policy put into place in March(?) of last year that any additional property purchased here beyond the primary residence needed at least a 50% down-payment. As I mentioned before, purchasing a primary residence requires a 30% down-payment, plus meeting residency requirements of having paid payroll taxes here for at least five years.

I’m really enjoying your pieces about the real estate market… nice to have a perspective (without hype) from someone who lives here.

That’s great! Thanks for the additional data on Beijing! One of the hardest things to do is to write about China generically because each province uses different control mechanisms. Property taxes are being pushed at a high level and I think they’re likely to be introduced around the rest of the country over the next 2-3 years.

The residency requirement is annoying, I know it’s designed to stop foreign speculators from driving up real estate prices – but the control has failed in real terms, because a lot of Chinese made a lot of money out of partnering relationships to enable foreign speculation anyway.

The downpayment for a mortgage is much larger than back home and again should contribute to a softer landing for the Chinese real estate market. Thanks very much for adding so much info. 🙂